Monday, April 6, 2009

Best & Worst 10-Year Returns in Stock Market History (thru 2012)

10-Year Rolling Returns (Decade Returns)

This post graphs not only the best and worst decades in stock market history, but returns for all 10-year periods since around 1900; these are so-called 10-year rolling returns.

Stock Market "Rolling" 10-Year Returns Graph

Dow 10-Year Rolling Returns

Above is a graph of the 10-year total return of the DJIA (Dow Jones Industrial Average) beginning around 1900. (Note: Click on graph to expand it.) Each point on the graph represents the average annual return earned by a hypothetical investor who bought the Dow at that year-end and sold 10 years later, reinvesting dividends in the interim. For example, the first point on the graph shows that an investor who bought at year-end 1900, reinvested dividends annually, and sold at year-end 1910 earned 6.8% per year. Note that the returns prior to 1929 are estimated (which is why I sometimes omit them).

Stock Market Returns for a Decade are Cyclical, and Can be Negative

This is the same data as was used for the 10-year return histogram in the Stock Market Yearly Returns since 1929 post. However, this presentation gives us a significantly different impression. The histogram left us with the impression that 10-year returns have been consistently between 0% and 20%, and much less variable than yearly returns. That's true. However, that presentation was incomplete because:

It completely hides the cyclicality.

It started in 1929 and missed the fact that 10-year returns can in fact be negative (a key reason why I started in 1901 for this post)

Note: FYI, the decades ending in 2008 and 2009 didn't make the above list, but they're next. The decade ending in 2009 is 6th at 1.3%; 2008 is 7th at 1.7%. For the most recent 10 years, ending 2012, the return was 7.2%.

Average Returns for a Decade, and the Impact of Inflation & Expenses

On average, stock market returns for a decade were around 10% per year. However, the 10-year returns varied considerably, depending on your "start year."

The graph shows several instances of near-zero 10-year returns. To my way of thinking, a decade is a long time to go with essentially no return on your investment. In addition, there were a number of 10-year periods with returns of 5% or less. Remember, these returns have not been adjusted for inflation. If you assume that over this period inflation has averaged about 3% per year, then the less than 5% nominal returns become less than 2% in real terms, and the near-zero returns become negative. (For a more detailed discussion of nominal vs real rates of return, see this post.)

A Better Way to Look at Stock Market Returns -- Especially for Retirement Planning

The graph above should make it clear that investors don't always get average returns! Sometimes returns are above average; sometimes returns are below average. What if the market returns only 5 or 6% in the next 10 years instead of 10%? What are the chances of that? What impact would that have on your retirement portfolio? See What Will a $10,000 Stock Market Investment be Worth in 10 Years?. You may be surprised.

Note: The above charts are based on DJIA (Dow Jones Industrial Average) data from my Stock Market Analysis Spreadsheet/Model. If you have trouble downloading the Excel spreadsheet, see this post. Results would be essentially the same if we used S&P 500 data. Dividends prior to 1929 have been estimated based upon another stock market index.

This is great work--thanks for doing it. However, your 10 year forward returns presentation would be much more impactful were it stated real rather than nominal terms. You correctly pointed out that inflation would have an impact. I wasn't able to get into the internals of your model, but it seems to me that: 1) inflation per year is known for the periods modeled, and 2) nominal returns (which you've shown) could be fairly easily converted to real terms. Doing so would present an more reasonable picture of how stock market returns would affect an individual.

For instance, my guess is that were you to use real rather than nominal returns, the decade beginning in 1928 wouldn't make the list of top ten worse decades. The early years of the 1930's were years of significant deflation, not inflation.

I would also suggest using the S&P rather than the Dow for sever reason--to begin with the DOW is improperly weighted and therefor isn't a particularly good surrogate for the stock market, and the DOW is also a poor market representative because it doesn't capture the economic impact of the most dynamic portion of the market place, that being small cap companies. The S&P has a better construct from and index prospective and also provides a considerably better model of the economy. I also realize that using the S&P would increase your work load unless you used another source for the S&P data. Robert Shiller has already done this work and it can be found at the following link: http://www.moneychimp.com/features/market_cagr.htm

I agree rolling real returns would be useful. Not sure I agree that they're better; I think it's instructive to look at it both ways. This post is an early post -- before I had long-term inflation data. Since then I have added an inflation-adjusted stock market post. I hope to add more this year; rolling 10-year returns is high on that list.

I also agree the S&P is theoretically better/sounder. However, I question whether the switch would lead to significantly different conclusions since my investigations are at such a high level. Still, I haven't ruled it out -- it's just not a priority at this point. I'll continue to revisit.